Principles of Basic Property Negotiation

What is Negotiation?

There isn’t a quality business that is just about its product or service. It’s real value is how that product or service can improve upon the lives of the people who use it. But even a business with a product that can immensely enrich its customer’s lives cannot survive unless it communicates this fact with them first.

All honest business is about effectively helping people. It is the basis of a capitalist economy. Your real estate business MUST focus on this idea. Success or achievement therefore in real estate or anything else is the result of effectively dealing with people.

The concept was made clear to me as early the 11th grade where during an Occupational Orientation class Mr. C. E. Smith (no relation) taught that it is not the possession of technical skills that secures a job interview but their presentation in part in a resume and cover letter, it is salesmanship in the interview that is rewarded with an offer, social skills that maintain employment during and after any probation period, and conceptual skills and their communication that allow for advancement later on.

The common denominator here is convincing other people (in this example to interview, hire, keep, and promote you) that what you have to offer in exchange is of more value to them than what they are trading to obtain it, while at the same time keeping the reverse a net positive transaction for you as well. The irony of a well done negotiation is that both parties leave a transaction with more value than they contributed.

Negotiation on the surface is entirely about 1 thing – affecting decisions and behavior (not just of others; it is sometimes about influencing the decisions and behavior of ourselves). Everyone is doing it every day. Whether you realize it or not you are negotiating every time you communicate; with your spouse (even silence is a form of negotiating), children, parents, coworkers, employees, bosses, customers, vendors, neighbors, pets, politicians, waiters, postmen, etcetera, etcetera, etcetera.

Even a simple excursion to the cinema with your best girl is the result of a series of negotiations. “I’m really anxious to go see that new Star Trek movie Sweetums, would you like to go? Well then what movie would you like to see, Honey? Is 8:00 ok, Pumpkin? Do you want popcorn or nachos, Sugar? Soda or Diet Soda, Babe? Are you sure Darling? Would you like to sit up front or in the back, Doll? Excuse me are those seats saved? Do you mind if we share the armrest Dear? {To yourself: Should I (hold her hand, try to kiss, put my arm around her, touch her knee . . .)}?

Price isn’t everything . . . but it’s almost always one of the main things

In that string of questions about going to the movies, what do you think was the most important one? It is a trick question because the most important question wasn’t even asked; in fact not only was it not asked but an affirmative response to it was assumed. That question was, “Would you like to go on a date with me?” Everything else was just for added value.

One of the mistakes that many novice real estate investors make when submitting offers is addressing what is assumed to be the most important point to the seller first and addressing it forcefully to try and establish position. That point is purchase price. I am approached weekly by someone who speaks of having made 5, 10, 20, even 30 offers on properties and received as many rejections. Upon hearing this, the first question I ask is “How close to the list price are your offers?” The response is almost always what most industry professionals consider to be a “lowball” offer.

While it is of course of utmost importance for you buy property at a price that allows you to meet at least your minimum standards for rates of return, it is also usually just a waste of time for you and your agents to write lowball offers. Nathan Dennis, the Broker for Lifestyles Realty, Inc. recently shared with the Lifestyles community some very interesting data regarding these kinds of offers.

A survey of Texas real estate transactions revealed that 36% of sales closed at or above list price, while only less than 3% closed below 90% of list price; at best the lowballers experienced a 1 out of 30 success ratio. You’ll burn through many if not all of your real estate agent contacts by continually asking them to write contracts like this. It is a much more efficient use of time to target properties where you can offer the seller most of or more than they want provided the deal still works for you.

That leaves 61% of the sales closing between 90 and 99 percent of list price. The sellers aren’t getting everything that they hoped for, but the deal worked for them anyway. One of my favorite (Non-real estate) examples involves Jenny McCarthy, a famous model who made millions for herself and her former employer, Playboy Magazine.

Some would argue that she is so beautiful that she could attract whomever she chose, perhaps a man of equal attractiveness (someone in her good looks price range) like Brad Pitt or Tom Cruise. The offer she accepted from Jim Carey however indicates a partiality for a man with a sense of humor and reasonable looks, but note that she didn’t take a lowball offer on physical attractiveness from Bozo the Clown either. I’m all too familiar with this as I married way above my good looks price range too, but must’ve brought something else to the table. Donald Trump did the same thing 3 times. The point is that if a property owner has options and little need to sell, then don’t expect them to accept your offer of significantly less than asking price. Your offer to purchase the property has to provide more value to them than continuing to own it.

Some of the other stuff in the contract

The idea then is to discover what the seller values and make your offer appear to be a stronger fit for their needs and desires. The following example offers several of these considerations. I listed a property recently for $109,900 that had comparable sales of $115,000. Within days I received four offers between $102,000 and $107,900. I accepted the lowest price offer (we’ll call Offer A) mostly because it was all cash with no contingencies, two weeks to close, and their daughter and grandchildren lived two houses over. It was as close to a sure close as you can get.

Offer B was the highest at $107,900 and the buyer was pursuing an FHA loan. Because of the loan type I would have had to pay extra closing costs which lowered my net proceeds on 2 of the other 3 offers. Offer C was $105,000; the buyer was pursuing 100% financing so I wasn’t confident that they could close and passed. The same buyer countered at full price but did not change from a 0 down loan so my confidence remained suspect. Offer D also started at $105,000 but asked for a 15% owner carry-back 2nd note at 8% interest.

I countered this offer with the price at full appraised value $115,000, 2nd mortgage at 9.9% interest. We agreed to $110,000 but they balked at my insistence on a credit check. So I went with the “sure thing” at $102,000. Since I had purchased the property 3 years earlier for $72,000 and estimated the value at that time to be $95,000, even offering a discount to my buyer yielded a substantial profit. The take away here is that my motivation was to time the sale to reinvesting quickly; effectively releveraging my equity and I more than gained back that discount. And because the buyer met my desires for a quick, more certain closing they bought a property with instant equity.

While it may seem daunting at first to think about navigating a 24 section, 8 page real estate contract and several addendums, the all important first phase in negotiating is preparation, so get to know it well. Plus, there are several places where you can protect yourself, save money, make money and at the same time increase the perceived strength of your offer just by the way you present it. Some of these contract points where you can sweeten the deal include:

Title Insurance: It is customary in Harris County, TX for the seller to pay for Title Insurance—after all why wouldn’t they insure that they are offering a clean title? But it is exactly the reverse in other parts of the country and even the state, for example HUD will not pay for title insurance so if you want it (and you do) then you will have to buy it when purchasing from HUD. This can be a point of negotiation with most other sellers though regardless of custom.

Earnest Money: If you have included a termination option in your contract one way to make it look stronger without really offering anything is to increase the amount you deposit for earnest money. It isn’t at risk with an unrestricted right to terminate until the option period expires and is applied to the purchase at closing.

Termination Options: Buying the right to terminate the contract gives you an out for any reason especially should you discover an undisclosed defect associated with the property. If you have the ability to complete your due diligence quickly then make your option period shorter. And this fee too can be applied to the purchase of the property; by offering more for the right to terminate and asking for a shorter option period your contract will appear stronger.

Closing Costs: It is very common for buyers to ask for the seller to make a contribution to help pay some of their closing costs. Investor financing will usually allow for a 2% contribution and owner occupant lenders will allow 3%. If you can raise the price to compensate for this contribution it can make your offer look better because of the higher sales price and at the same time reduce your cash out of pocket requirements which will raise your cash on cash return. Conversely if you omit a contribution request in your offer point out to the seller that you are a strong enough buyer to pay your own closing costs.

Property Condition: The phrase “as-is” comes across as very powerful, so use it. Remember again when the contract contains a termination option you still have an escape if something undisclosed turns up and the seller refuses to correct. Property condition can be one of the most lucrative negotiating points in the transaction. This is because a competent listing agent will advise their client to enlist a contractor to estimate repairs. If they cannot afford or do not have time to follow through with those repairs, the listing price would be adjusted to compensate a buyer to make them plus a premium for the trouble. The best part is that the sellers typically over estimate how much the repairs will be because they are using retail estimates, and you will be using discounts and favorable treatment from your network of professional vendors.

Financing: If you have the ability and are willing to use a large down payment or pay cash if your high leverage loan falls through then write your contract with a very conservative financing contingency. As demonstrated in the example above this strengthens your offer in the eyes of the seller and you can still pursue your aggressive financing intentions as long as you have that fallback position.

Closing Date: An earlier closing date indicates confidence that the funding is already in place and therefore adds strength to your offer. Many Hard Money products allow for an expedited closing and if the value is good enough for you, and timing is important enough to a seller, a 14 day vs. 45 day close will be the difference maker.

Fixtures and Appliances: The contract promulgated by the Texas Real Estate Commission lists many of these items and specifically states that anything attached to the property is a part of the property. You can actually then sell these items, like the owner’s stove or ceiling fans back to them for a price reduction (as you begin to collect houses you’ll begin to collect these things anyway). Additionally, by including things like the washer/dryer, refrigerator, lawnmower, or anything else on the property as a red herring, you’ll have some things that you really don’t care about that you can trade away later for something that matters more.

But remember it’s about people not paper

Preparation for negotiating the purchase of investment homes also means that you are required to learn as much as you can about each of the players. The primary ones are: you, your agent, the seller’s agent, and the seller. Each of these relationships will have its own usual points of contention, and by determining their underlying motivations you can position yourself with advantage.

Keep in mind that ego can be a formidable obstacle and is the first one to address with each contact, so the second phase in negotiating is building rapport. When the ego gets attached and just wants to look like it won, instead of actually getting the desired result, then heels start to dig in and rapport becomes important. The goal with phase 2 is to position you on the same team as the player in question.

Dealing with You: “Build rapport with myself?” Yep. You have an ego too. Yours is telling you things like “I haven’t bought a property yet this year, loser. Just give in and get past the first one, it’ll get easier from there. I just need to bust this slump.” Even worse, “I know the numbers don’t work with the contractor’s estimate, but I’ll do it all myself – I’m better, faster, and cheaper than he is anyway.”

Another manifestation of the ego is when for example in an auction/bidding scenario and in the “heat of the battle” you care more about sticking it to the other guy than actually making a sound investment. The solution is for you is to have confidence in your preparation, remembering that your CMA and property evaluation is accurate and objective; know your maximum allowable offer and never exceed it.

Dealing with your Agent: Your agent’s first concern is that the deal actually closes. The second is a cost/benefit analysis regarding the how much work you are and if it’s worth it to keep working with you. Keep these two points in mind, behave accordingly and your agent will go to the ends of the earth to make sure you know of their best deals first. For example, every agent I work with knows that they don’t have to drive me, meet me, or go anywhere to show me a property. I can decide whether to write an offer on an individually owned and many institutionally owned properties with just my own research and the information they provide, and I can make this decision very quickly.

Dealing with the Seller’s Agent: Your seller’s agent has an even bigger desire to reach a speedy closing as well. The first reason is apparent, a paycheck. The second is for reputation. A competent listing agent markets their closing ratios, sales price to list price ratios, and their own days on market to average days on market ratios. A good listing agent will recognize investors who demonstrate that they can move quickly and make that contact their own for future properties. By improving their stats, listing agents include it in their sales presentations and list more properties. You aren’t just a paycheck to them, but leverage for more listings and abundantly more paychecks, and in turn more opportunities for you to buy.

Dealing with the Seller: When neither party is represented by an agent, there can be fireworks. Remember that ego is usually the central reason someone doesn’t hire their own agent, because of (usually false) confidence that they can save money and “still get their price.” When an investor approaches the seller directly with interest there is suspicion right away that he is a vulture preying on someone’s hard times. Sellers in rough circumstances can feel vulnerable, afraid, embarrassed, and angry. I suggest that you do the opposite in this situation than common instinct would suggest which would be trying to put the seller at ease by saying something about being there to “offer help” or “avoid foreclosure.”

Instead, openly admit that you are in business to make a profit, this will be a business decision for you, and your feelings won’t be hurt if your proposal doesn’t meet his needs. Then ask, “Does that sound fair?” or “Are you comfortable with that?” Assuming an affirmative response then ask directly what those needs are and work toward framing your offer in such a way that they are best addressed. Now you and the seller are collaborating on a project together instead of being opponents. (Note that If the seller is represented the listing agent should have asked these questions already, and if proficient will have noted urgency in the listing, pricing, and/or terms available.)

But I want to duke it out!

Since Phase 1 is about knowledge and Phase 2 is positioning, then when are you going to fight for what you want. I hate to disappoint so here goes: the third phase in negotiation is skillfully employing tactics. The only three negotiating tactics with which most people are familiar are the lowball opening offer, splitting the difference, and walking away (usually a bluff).

The lowball and split have been proven to be ineffective, and walking away has been so overused that it just doesn’t provide the impact it used to. By mastering just a few fundamental additional skills you can significantly increase the probability of resolving any divergent issues in your favor. Don’t forget about the assumption close and the red herring strategy discussed earlier while you consider some of the ideas below. The list shared here is by no means comprehensive nor must you go and learn every gambit ever invented to be effective—choose a few and master them.

The “Barney Zick Shout Back”: One of the most fun business seminars I’ve attended was a presentation on negotiation by the late Barney Zick. His material was as poignant as it was hilarious. Try this 2-step tactic with anyone you ask for a price. When they answer with the price—step 1: shout it right back to them with a contorted and painful facial expression; and step 2: shut up. I mean it, don’t talk. I’ve even used it with success at The 99¢ Store.

Questions Only: When interviewing real estate agents to build your team one of the clues to whether the one you’re talking to is a real sales professional is how they take control of a conversation. The tool they will use to accomplish this is questions. “Are you prequalified? How much money are you looking to invest? What size property are you looking for? What part of town? Etc.” You too can direct the conversation to the topics that you desire, thus framing your offer in a more favorable context by focusing on how it resolves the seller’s concerns.

Breaking Down the Dollars: This is especially effective if when working directly with the seller and using owner financing. For example if you are $10,000 apart in price then you can show them that they’re haggling over an extra $60 per month that they have to pay taxes on, but for you it means higher insurance and two kinds of taxes in addition to the $60 per month, which would significantly eat into the cash flow; making your ROI too low and potentially jeopardizing your ability to make timely payments.

Multiple Choice: “Sweetheart, were you planning to use that awesome new roast recipe we tried last time for dinner tonight, or were you thinking of broiling some fish?” Whether my wife’s answer to this question is the roast or the fish—I still win a delicious dinner prepared with loving hands that aren’t mine. When making an offer on property, ask these kinds of questions too. For example, “Mr. Seller, were you planning to replace that water heater prior to the inspection, or wait and see if it comes up during?”

We have an agreement

Now that you’ve worked out the details it’s time for phase 4, executing the contract. This is the most straight-forward part of the process but is as critical as any other. Review what you have agreed to, and if you or your agent hasn’t done so already, complete the contract.

Verify that the document you are signing includes each of the points that you agreed to and that no changes were made, and after both parties sign it’s time for you to move on to the next part of your real estate adventure—your due diligence period. Now you get to practice your negotiating skills with a whole bunch of new people: inspectors, contractors, lenders, insurance agents, and later on . . . tenants! Happy Investing!

Comments

Thanks Chuck – That is mostly because LR agents are writing on so many REO’s, and the banks who own them are exempt from disclosure requirements. On many of those institutionally owned properties I have already visited the property even before the agent has had a chance to get there, so I can call them off if I have enough information. If I am not permitted access then on those properties the agent will meet me there if I decide to proceed, but I’ve already prequalified it with a cma and a drive by before calling the agent out. On properties owned by individuals the Owner’s Disclosure of Property Condition and and the agents description provides more than enough information for me to comfortably make an offer. Hope this explains the sentence that followed the one you quoted a little better, as one of my goals here is to add value to my relationship with the agents.

So I was able to negotiate that trip to see Star Trek last night with my best girl. It turns out that a very powerful tool that I didn’t mention in the article is ‘The Referral’. While Dawn was poking fun at my dorkiness for wanting to see the movie on the Imax, she was told by many that it was indeed a good movie and she should go with me especially while it was showing on an Imax screen. We can do the same thing in Real Estate by keeping a reference book . . . a collection of letters from past satisfied sellers, buyers, tenants, agents, lenders, partners, contractors, etc.

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